ISSN 1392-1258. EKONOMIKA 2014 Vol.

93(4)

SUBPRIME MORTGAGE CRISIS

IN THE UNITED STATES IN 2007–2008:
CAUSES AND CONSEQUENCES (PART I)
Vaidotas Pajarskas, Aldona Jočienė*
Vilnius University, Lithuania

Abstract. The main purpose of this article is to determine which factors and how contributed to the subprime
mortgage crisis in the United States in 2007–2008, what their causal links and effects on the markets and
the whole economy were, and to assess what actions could have been taken by the Federal Reserve and the
Government in order to mitigate or prevent the consequences of subprime mortgage crisis and housing
bubble. In order to obtain the research results, the authors performed a qualitative analysis of the scientific
literature on the course of events and their development that led to the subprime mortgage crisis, and focused
on the insufficiently regulated home mortgage market expansion, the impact on the subprime mortgage crisis
of financial innovations and financial engineering, poorly evaluated systemic risks and policy undertaken by
both the U.S. Government and the Federal Reserve before and after the crisis. The quantitative research focused
on two main parts: firstly, analysis of the dependence between the causes of subprime mortgage crisis and the
consequences, using a statistical and regression analysis, and secondly, an alternative path the Government
and the Federal Reserve could have taken in their policy actions and the results they could have produced.
The authors believe that the results of the research could give useful guidelines to the central bankers and
government officials on how to make long-term decisions that can help in preparing for the financial distress,
mitigating the consequences when the crisis strikes, accelerating the recovery and even preventing the crisis it
in the future. The second part of the qualitative research will appear in the next issue of the journal.
Key words: banks, Central bank, subprime mortgage crisis, mortgages

I. Introduction
Since August 2007, global financial markets have been shocked by catastrophic events
and circumstances stemming from problems in the U.S. subprime mortgage segment.
Financial institutions were forced to write down billions of losses in dollars, euro or
Swiss franks. The main markets stagnated, their liquidity almost disappeared, and stock
markets suffered massive recession. Central banks originated hundreds of billions of
loans making interventions not only to support the exchange rate, but also in order to
preclude the collapse of separate institutions. The USA and European governments also
intervened in the large-scale support to financial institutions. Huge losses forced the

* Corresponding author:
Vilnius University, Faculty of Economics, Vilnius University, Saulėtekio Ave. 9, LT-10222, Vilnius, Lithuania.
E-mail: vaidotas.pajarskas@gmail.com; aldona.jociene@ef.vu.lt

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great majority of financial institutions to recapitalise, some of them were taken over by
other financially stronger institutions, and others simply went bankrupt. In August 2008,
the International Monetary Fund (IMF) expected total losses to reach almost USD 1
trillion, but in October its expectations were revised up to USD 1.4 trillion, so the cost of
the recent global financial and credit crisis for the global economy was one of the highest
throughout its history.
The effects of many previous large-scale financial crises had been more localised
– affecting the economy and financial sector of one particular country. The recent
crisis was unique – it was more complicated than any previous crisis (e.g., the Great
Depression of 1929–1930, the USA Savings and Loan Crisis of the 1980s and the 1990s,
the USA Long-term Capital Management Crisis of 1998 or the collapse of “dot-com”
(IT) bubble of 2000–2001), while its damage is considerably more widespread among
both the countries and financial institutions – banks, pension funds, investment banks,
insurance undertakings, etc.
It is widely agreed that the subprime mortgage crisis was caused by the credit boom
and the housing market bubble. However, it is not so clear why this combination of events
has evolved into such a severe financial crisis, i.e. why the financial system suffered the
freezing of capital markets and the widespread collapse of financial institutions, why
the housing market and credit bubble were so inflated, and how and what factors on the
part of the private and public sectors had the essential impact. The subsequent systemic
crisis reduced capital supply and availability to creditworthy institutions and individuals
increasing the negative impact on the economy even more. The main hypothesis of this
research is that the central bank, the government and the private sector have done not
everything they could to control the formation, expansion and consequences of the crisis
and, moreover, they themselves have contributed to the subprime mortgage crisis.

II. Literature review. Unregulated growth of the mortgage market

Over the last years, analysis of causes of the subprime mortgage crisis in 2007–2008 has
become the subject discussed by many economists and governments. The U.S. subprime
mortgage and credit crisis was analysed in research and papers of Acharya et al. (2009),
Isard (2009), Crotty (2009), Donnelly et al. (2010), Lim (2008), Jaffee (2008), Demiroglu
et al. (2011), Purnanandam (2010), Crandall (2008), Schwarcz (2008), Simkovic (2011),
Moran (2009), Taylor (2007), Carrillo (2008) and other researchers. Authors basically
emphasised the relevance of the contribution of both the private sector and governmental
organisations to the subprime mortgage crisis.
After the prolonged period of rapid expansion, the economic activity started receding
in many countries of the world. The sharp turnaround was associated with the end of the
house price boom in the United States. It is necessary to understand how short-sighted

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mortgage lending practices and financial engineering turned the global economy into a
house of cards, and why the U.S. authorities did little to curtail the outrageous lending
practices and financial engineering (Isard, 2009).
The direct cause of the financial turmoil was the steep increase and subsequent sharp
decline of housing prices, which, together with poor lending practices, led to large losses
on mortgages and mortgage-related instruments in many financial institutions (Moran,
2009). Although the recent financial crisis was caused by the burst of mortgage market
bubble when massive default on obligations in the subprime mortgage market started,
but the financial bubble of the housing market was the result of the development of
financial innovations over the past three decades, which essentially is one of the main
causes of the subprime mortgage crisis (Lim, 2008).
Subprime lending growth was boosted by more highly leveraged lending against a
background of rapidly rising house prices. A strong investor appetite for higher-yielding
securities contributed to looser loan granting and mortgaging standards. However,
safeguards ensuring prudent lending were weakened by the combination of remunerations
and bonuses at each stage of the securitization process and the dispersion of credit risk,
which weakened loan monitoring and control incentives. Hence, intermediaries were
remunerated primarily by generating loan volume rather than quality (Kiff et al., 2007).
As long as housing prices kept climbing, fuelled by ever-increasing levels of debt
and leveraging, all these problems remained hidden. Rising house prices provided the
borrowers in financial trouble with an incentive to sell their homes and pay off their
mortgages prematurely. In 2006, when prices peaked and began to fall, things started to
unravel. After several years of unsustainable housing pricing appreciation and imprudent
lending practices, a housing market correction – the bursting of the bubble – was both
inevitable and even necessary. As interest rates rose and house prices flattened with the
loan value and then turned negative in a number of regions, many stretched borrowers
were left with no choice but to default as prepayment and refinancing options were not
feasible with little or no housing equity (Kiff et al., 2007). This subprime mortgage
crisis, marked by home foreclosures of enormous scale and illiquid mortgage-related
securities which have created huge capital holes on the balance sheets of banks and
financial institutions has spilled over into the global economy, causing a global credit
crisis and fuelling a deep, long, and painful recession (Moran, 2009).
While discussing the causes of the subprime mortgage crisis, different researchers
and economists have pointed out and distinguished different factors contributing to the
crisis. Different researchers have expressed different views about the relative importance
of the contributing factors and how the blame should be shared (Isard, 2009). This
paper introduces three groups of the root causes of the U.S. subprime mortgage crisis
considered to be the main by the authors: 1) problems directly and specifically related

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to the subprime mortgage lending practices; 2) causes related to the subprime mortgage
securitizations; 3) causes related to the ability of financial institutions and public
authorities to assess the systemic risks.

Roots of the crisis: collapse of “dot-com” bubble and 11 September

Moran (2009) notes that roots of the subprime mortgage crisis stretch back to another
notable boom and burst, i.e. the tech bubble of the late 1990s and 11 September. In
1998, turmoil in the financial markets became rampant. The spectacular failure of the
Long-Term Capital Management, a hedge fund of the U.S., in the 1990s led to a massive
bailout by other major banks and investment companies and helped persuade the Federal
Reserve to provide three quick interest rate cuts that contributed to the “dot-com”
bubble. When in 2000 a steep decline began in the stock market and the next year the
U.S. slipped into a recession, the Federal Reserve, once again, sharply lowered interest
rates to diminish the effects of collapse of the “dot-com” bubble and combat the risk of
deflation (Moran, 2009, p. 13–15).
The “dot-com” bubble collapse was followed by tragic terrorist attacks of 11
September, as a result of which the Federal Reserve cut the interest rate even further.
Thus, Moran (2009) again emphasises that the series of actions by the Federal Reserve to
lower interest rates and hold them at historically low levels (1%) for three years partially
fuelled the housing bubble and eventual crash that triggered the subprime mortgage crisis
and the recent financial crisis. Fisher (2006), president and chief executive officer of the
Federal Reserve Bank of Dallas, stated that the Federal Reserve’s policy of significant
reduction of interest rates during this period was irrational first of all because of
erroneously low inflation data and, therefore, contributed to creating the housing bubble.
These low nominal and even negative real inflation and adjusted inflation indicators
sparked a building and buying boom in housing, which developed into a huge speculative
bubble. Lower interest rates made mortgage payments cheaper, caused increased
demand for homes, resulting in a considerable increase in their prices, and encouraged
investors to pour money into the U.S. mortgage market. In addition, the demand was also
fuelled by refinancing mortgages by millions of homeowners taking advantage of lower
interest rates. However, while the housing market prospered, the quality of the granted
mortgages deteriorated. Consequently, when in June 2006 the Federal Reserve brought
interest rates back to 5.25%, the real estate bubble began to deflate, and about one year
later the housing price correction developed into a financial crisis (Moran, 2009).
A study conducted by Stanford University Professor Taylor (2007) suggests that the
federal government could have avoided a large portion of the turmoil associated with the
financial crisis if the Federal Reserve had not cut interest rates so significantly and raised
them again quicker. Taylor’s simulated studies tried to increase interest rates quicker than

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the Federal Reserve, and the result was positive – the increase in new homes’ market was
smaller than the one which actually occurred. These results show that if interest rates
were raised sooner it would have helped in avoiding the building of such housing bubble
and a sharp fall in the housing market, while concurrently mitigating the consequences
of the financial crisis.
Obstfeld et al. (2009) also stress in their paper the role of the independent monetary
policy in the context of the subprime mortgage crisis; however, they note that the
monetary policy was accompanied by massive inflows of foreign investment to the U.S.,
which together stimulated an excessive domestic consumption. Household consumption
was the main driving force behind the economic growth and accounted for about 2/3 of
the GDP growth. Export surplus and excessive savings in other countries of the world
(mainly Asian countries) allowed supporting the individual and government consumption
in the U.S. In 2007, the U.S. trade balance deficit totalled USD 790 billion, 93% of which
were financed by countries with trade balance surplus – China, Japan, Germany, and
Saudi Arabia. In other words, since 2004, massive capital inflows reached the U.S. and
financed the issues of asset-backed securities, while purchase volumes of government
bonds declined. Thus, the subprime mortgage market was also flooded with investors
from Asia and other countries holding large amounts of free funds and seeking profit, and
this was another reason for the rapid expansion of the market.
Jaffee (2008) expressed a slightly different view towards the origin and beginning
of the subprime mortgage crisis, arguing that financial market innovations, as one of the
driving forces behind the growth of the subprime mortgage segment, are commonly related
to three main conditions all highly relevant to the origin of the subprime mortgage lending:
• the existence of borrowers and investors who have been previously underserved.
Subprime borrowers were eager to use mortgage loans to finance home purchases,
while excessive worldwide savings created large numbers of investors eager to
earn the relatively high interest rates promised on subprime mortgage securities;
• the catalyst of technology advancement and know-how. Subprime mortgage
securitization applied state-of-the-art tools of security design and financial risk
management, expanding the successful implementation of such tools to earlier
high-risk securitization practices ranging from credit card loans to natural disaster
catastrophe bonds;
• a benign and even encouraging regulatory environment. Although the U.S.
mortgage lenders face a complex network of state and federal regulations, only
few of these regulations impeded the origination of subprime mortgage loans.
Furthermore, the existing system of capital adequacy requirements of commercial
banks provided banks with strong incentives to securitize many of the subprime
mortgage loans they originated (Jaffee, 2008, p. 2).

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Expanding volumes of homeownership and growth of the housing market
The events leading to enormous losses of the global economies began many years ago,
starting with lax and imprudent lending practices by banks and financial institutions, and
furthered by borrowers buying houses they could not afford and taking loans they could
not repay (Moran, 2009). Carrillo (2008) in his paper noted the problems arising in the
lending sector (Fig. 1, blue chain).
Homebuyers took loans betting on continued house price appreciation (Carrillo,
2008). Hirsch (2008) (Fig. 1, supplemented with the lower grey chain) also supplements
this scheme attributing to the significant factors the favourable initial terms (no down
payment, no or low payments for the first two years) and existing possibilities of
refinancing, which, coupled with the problems raised by Carrillo (2008), resulted in
overextended mortgage origination volumes, which in 2003 reached the peak at USD 4
trillion compared to the historical USD 1.45 trillion in 1998. At this point, Moran (2009)
distinguishes one more negative aspect of such borrowing and house purchase, i.e. as
home prices kept appreciating, even prime borrowers with an excellent credit history
became more willing to assume risk to purchase homes for adjustable-rate mortgages
further contributing to the inflating bubble of house prices.

Lenders lowered and weakened

Real estate boom sparked
excessive demand and drove up
housing prices
Weak underwriting standards
their underwriting standards
for mortgages and house price
and crafted creative loans to
appreciation encouraged home
provide money to high-risk
buyers to take many loans
clients

Possibility to refinance taken

Easy initial lending terms (no
down payment, no or low
payments for the first two years)
encouraged borrowers to take
costly and difficult mortgages
loans under more favourable
terms and get cash from
house value appreciation
permitted borrowers to become
overextended

FIG. 1. Mortgage sector problems*

* prepared by authors based on Carrillo, 2008; Hirsch, 2008.

Mortgage brokers viewed their loans as well-secured by the rising values of their real
estate collateral, but paid no attention to the ability of borrowers to repay the loans when
due. Millions of homeowners took advantage of the interest rate drops to refinance their
existing mortgages, but when the interest rates started increasing and housing prices
decreasing in many parts of the U.S. in late 2006 and early 2007, the refinancing of their
existing loans became more difficult (Brescia, 2008). According to Moran (2009), when
housing price appreciation began to slow down, the consequences of weak underwriting

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started manifesting themselves, including the above-mentioned little or no documentation
and zero or minimal required down payments. Some homeowners unable to refinance
their loans started defaulting as their mortgage loans reset to higher interest rates and
payments, or the market value of the home fell below the value of the taken loan.
Jacoby (2008) investigated the behaviour of homeowners and related risks in her paper.
The researcher argues that for most households in the United States “home equity” – a
function of forced savings in fixed-rate mortgages and long-term real estate appreciation –
has been the most substantial source of wealth. This, as also noted by Moran (2009), makes
homeownership an efficient and effective way to develop wealth because:
1. Home equity appreciation remains the primary savings mechanism for a great
majority of the U.S. population.
2. Non-conforming financing also brought about unexpected success to existing
homeowners, which lenders capitalised on through the encouragement of home
equity withdrawals.
3. Individuals and families accessed and used this new source of credit to extract
previously illiquid home equity wealth through refinancing.
4. A huge real estate speculative bubble in housing prices caused millions of Americans
to think of homes as a cash investment instead of as a place to live – over 2005 and
2006, almost 40% of homes purchased were not used as primary residences, but were
instead used as vacation homes or for investment purposes (Moran, 2009).
Over this time period, the housing bubble naturally saw substantial increases in both
homeownership (see Appendix 1) and home values. Homeownership rose to 67.4% of
U.S. households in 2000 from 64% in 1994 and peaked in 2004 with an all-time high
of about 69%. Between 1997 and 2006, home prices in the U.S. augmented by 124%
(CSI …, 2007). Although home prices nationwide experienced a rapid price appreciation
increases were especially pronounced in a few regions (such as California, Florida,
Arizona, and Nevada) where house prices more than doubled between 2000 and 2006. To
sum up, it can be concluded, that while constituting an admirable social goal and being
a plus for the economy, the increased homeownership has come at a very substantial
personal and financial cost to already financially strapped consumers as it allowed too
many individuals and families to become overextended and hold mortgages they simply
could not afford (Moran, 2009).

The rise of subprime mortgage lending and erroneous lending

and borrowing practices
The 2007 subprime mortgage crisis was distinguished by an unusually high share of
originated subprime mortgage loans, which was defaulted already in a few months,
and borrowers were deprived of their ownership rights. Crandall (2008) in his research

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argues that the first subprime mortgage expansion occurred in 1990s when governments
encouraged lending to low-income borrowers, technology advancement and achievements
made the credit risk assessment process easier, and the growth of the subprime mortgage
market enabled lenders to transfer subprime mortgage risk to investors.

TABLE 1. Origin of subprime mortgage loans and factors behind its rapid growth*

Factors behind the

Scientist / Implications of factors for markets, economy and social envi-
growth of subprime
economist ronment
mortgage loans
Moran The Depository Institu- The Act cancelled state interest rate ceilings for the majority of
(2009) tions Deregulation and mortgage loans and was meant to foster lending. However, the
Monetary Control Act principles of the Act also tolerated increased conventional mort-
(DIDMCA) passed by gage interest rates in states with low interest rate ceilings and
the Congress in 1980. encouraged the growth of the subprime market regardless of
the high interest rate limits on mortgage loans.

Moran Alternative Mortgage The Act contributed to the increased flexibility of the mortgage
(2009) Transaction Parity Act lending industry by allowing lenders to offer adjustable rate
passed by the Congress mortgages as part of their business transactions.
in 1982.
Carrillo Innovative and “exotic” While the housing market was still strong, lenders argued that
(2008) lending vehicles. innovative and “exotic” lending vehicles would increase con-
sumer access to credit, which did in fact occur.
Moran Placing more reliance Easy credit and weakening lending standards, coupled with the
(2009) on the collateral (home) assumption that housing prices would continue to appreciate,
value. created an increase in homeownership rates and the demand
for housing while encouraging many subprime borrowers to
obtain adjustable-rate mortgages, which they could not afford.
Johnston Adjustable-rate mort- For home buyers these lending mechanisms cost a lot less than
et al. gage loans. a thirty-year fixed-rate mortgage, at least at the inception of the
(2008) loan term. However, all types of adjustable-rate mortgage loans
concurrently presented the substantial risk that interest rate
increases will result in significantly higher monthly mortgage
payments, which did in fact occur, and the majority of borrowers
could no longer fulfil their obligations.
Prepared by authors based on Moran, 2009; Johnston et al., 2008; Carrillo, 2008.

What was peculiar to the he U.S. was the sudden rise of subprime lending. Different
mortgage interest rates and terms are classified into two main categories – prime and
subprime – based on the credit risk and the ability to repay of potential borrowers. The
terms “prime” and “subprime” refer to the credit quality of the borrowers, not the interest
rate of the loans. Generally, subprime mortgages are for those borrowers with a FICO
credit score below 620, while borrowers with a FICO credit score above 620 qualify for
prime mortgages (Crandall, 2008, p. 2–3). The prime segment has generally catered to
the most creditworthy borrowers, and the subprime lending, on the other hand, focuses

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on a greater number of higher-risk borrowers who do not qualify for market interest rates
because of different risk factors, such as income level, the down payment amount, their
credit history, and employment status (Johnston et al., 2008).
Different researchers look for the causes of subprime mortgage in different sources –
some of them find these causes in federal laws, others – in the attempt to try financial
innovations, or in the appreciation of house prices, or in the adjustable interest rates.
Having summarised and analysed the differing opinions and arguments, the essential
causes of the origin and rapid development of the subprime mortgage loans can be
distinguished. They are classified in Table 1.
The specifics and types of the subprime mortgage loans were investigated to a wider
extent by Jaffee (2008). In his paper, Jaffee provides a deeper explanation and elaborates
on the development of the U.S. subprime mortgage loans, the tendencies and volume
changes of which are explicitly shown in Fig. 2.

Subprime volume (left axis)

Subprime share (right axis)

FIG. 2. Development trends of the U.S. subprime mortgage lending volumes

(Jaffee, 2008)

Thus, it is obvious that starting with 1994 and continuing through 2007, subprime
loans were increasing quite rapidly both in terms of their absolute value and relative
share in the total volume of the originated loans. Figure 2 shows two distinct periods of
expansion in the subprime lending. The first period occurred during the late 1990s, with
subprime lending reaching an annual volume of USD 150 billion and as much as 13%
of the total annual volume of originated mortgage loans. This expansion ended with the
“dot-com” bubble collapse in 2000–2001. The second expansion started in 2002, reaching
annual loan volumes of over USD 600 billion in 2005–2006 and representing over 20%
of the total annual volume of mortgage loans originated in those years (Jaffee, 2008).

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The subprime mortgage lending volumes and their percentage in the total volume of the
originated mortgage loans reflect the lending practices of lenders – during the economic
upturn loan granting terms and standards kept easing, and collapse of “dot-com” and
later – the housing bubble was followed by the credit crisis in the course of which credit
standards were tightened considerably, the number of defaults in the subprime lending
sector increased, and credit institutions significantly reduced the amounts of granted
risky subprime loans (Simkovic, 2011).
The mortgage contract design has played an essential role in the subprime innovation
process during which numerous subprime mortgages have been created. Jaffee (2008)
and Kirk (2007) distinguish the following main types of the subprime mortgages:
• adjustable-rate loans;
• interest-only mortgages allowing borrowers at the inception to pay only interest
for a certain period, with the possibility of deferral of loan repayments;
• “balloon” mortgages, the repayment amounts of which kept increasing in the long
run;
• standard long-term, fixed-rate mortgages;
• “option” mortgages, which allowed borrowers to defer some of their payments;
• converting mortgage loans which start with fixed rates, then convert to adjustable-
rate loans;
• low document loans for borrowers that cannot provide complete documentation
required for a conforming loan;
• “Alternative-A” (or “Alt-A”) mortgage loans that essentially are between prime
and subprime mortgage loans because of one or more substandard features of the
borrower, ownership or loan.
These mortgage loans were all designed to meet specific needs: option mortgages for
borrowers with widely fluctuating incomes, converting mortgage loans for borrowers
who expected income growth in the future, etc. Many subprime mortgage loans were
also originated with the expectation that the borrowers would soon refinance into higher-
quality loans, assuming that the borrower’s credit rating would improve or the borrower’s
equity in the house would rise as the result of continuously rising home prices. The
subprime lenders also succeeded in attracting a significant number of borrowers who
would otherwise have been among the borrowers of higher-quality conforming loans
which made the effects of the crisis even more painful (Jaffee, 2008).
Consequently, due to the rapid expansion of subprime lending, the share of “Alt-A”
and various other adjustable interest subprime mortgage loans in the total volume of
the originated mortgages rose rapidly (Appendix 2). The transformation of the market
was such that of mortgage loans originated in 2006 only 36% were conforming loans,
15% were prime “jumbo” loans (which exceeded the ceiling for conforming mortgages),

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3% comprised mortgage loans guaranteed by the Federal Housing Administration
(FHA), while the remainder comprised “nonprime” loans “Alt-A” (25 %) and subprime
mortgages (21 %) (Kiff et al., 2007, p. 6).
Engel et al. (2007) focused on the lending policy pursued by banks and its relationships
with predatory acts. Their research was supplemented by Crandall (2008). The predatory
lending is defined by researchers as charging excessively high fees or interest rates or
using deceptive or unfair (legal or illegal) lending practices. Therefore, they include the
following behaviour of lenders in the “predatory” lending concept and also in the list of
causes of the subprime mortgage crisis:
1. Loan structure. An example of the loan structure, which is considered to be predatory,
is the so-called “2/28” (or “3/27”) loans. Over the first two years of a “2/28” loan,
a borrower pays a low fixed interest rate, the so-called “discount” interest rate, and
after two years the interest rate is adjusted every six months. The adjusted interest
rate usually was higher. Those borrowers who could not continue loan repayments
due to the higher interest rate tried to return to the lender for refinancing their loan
and obtaining one more loan with the “discount” interest rate for two years; therefore,
lenders were paid excessively high refinancing fees, and even 85 % borrowers could
not fulfil their “2/28” loan obligations soon after the adjustment of the interest rate.
2. Collection of fees / commissions. It covers fees or interest rates that are excessively
high compared to the borrower’s credit risk (e.g., fines for early repayment of a loan
which has been originated by bank knowing that it will need refinancing).
3. Illegal fraud or deception. It covers violations of the legislation on consumer rights’
protection and anti-predatory lending laws.
4. Non-transparency, discrimination. This category captures the non-disclosure of
mortgage lending prices and terms, racial and ethnic discrimination in lending, etc.
Generally, lenders have no financial incentives to engage in predatory lending
policies, because they don’t benefit from defaulting borrowers, but when home prices
rise, credit institutions are more inclined to pursue predatory lending because of the
possibility to cover incurred losses in case of default.
Demyanyk et. al. (2008), who analysed the subprime mortgage market and the quality
of originated loans in his scientific research, concluded that problems in the subprime
mortgage market had manifested themselves already before the crisis (Fig. 3). In late
2005, the monotonic deterioration of the subprime mortgage market was already visible,
and the quality of loans had been worsening for the fourth year in a row. The rapid
growth of home prices temporarily disguised the deterioration of the subprime mortgage
market and its actual risks, but when home equity appreciation stopped, market risk
immediately came to light, whereas when the bubble of housing prices collapsed and
borrowers started defaulting, the activities of banks became pro-cyclical, and in order to

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 Net percentage of national banks tightening underwriting standards*
Home Equity: High LTV Home Equity: Conventional Residential Mortgage
100
80
60
40
20
0
-20
-40
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
* Changes in underwriting standards as reported by national bank examiners. Net percentage
calculated by subtracting the percent of banks tightening from the percent of banks easing;
negative values indicate easing.

FIG. 3. Developments of mortgage underwriting standards, 1996–2011 (Simkovic,

2011)
Source: Office of the Comptroller of the Currency Survey of Credit Underwriting Practices
2011. Tables 45, 47, 51; OCC Survery of Credit Underwriting Practices 2002 pg 33–36

avoid further losses they significantly raised the lending standards. Thus, while in 2006
almost 20–40% (depending of the mortgage loan type) of banks weakened their lending
standards in order to generate higher benefits, from 2007 the situation changed to the
opposite direction, and for three consecutive years mortgage lending standards were
being significantly tightening until 2009 when they were made more stringent even by
80–90% of banks.

III. Analysis of the consequences and alternatives

of the subprime mortgage crisis
When analysing the consequences and alternatives of the subprime mortgage crisis, the
main ratio chosen for the assessment of consequences of the crisis and also of the housing
market was the number of new housing starts, because the formation and collapse of the
housing market bubble was the essential turning and starting point for all subsequent
events and development of the crisis. In other words, the research mainly focuses on
the number of new housing starts, therefore the analysis of the housing market bubble
creation and losses aims at examining how and what causes of the subprime mortgage
crisis covered by the first part of the paper affected the number of new housing starts, how
and why the housing market bubble inflated and collapsed bringing about huge losses
that are still being calculated for different financial institutions, country governments,
taxpayers and the rest of the public.
The number of new housing starts in the research has been chosen as the dependent
variable – a factor, consequence or result of several independent variables or causes

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that have been influencing it for a prolonged time (see Table 2). The list of independent
variables for the research was compiled in observance of the possibilities to assess them
in quantitative terms over the reference period and also having regard to their potential
direct impact on the number of new housing starts. Although the number of causes
analysed in the literature review was considerably larger, the research focuses on those
factors and causes, which could have been directly regulated or influenced by the central
bank or government of the country.

TABLE 2. Dependent variable and independent variables of the analysis*

Dependent variable
Independent variables (causes)
(consequence, result)
Federal funds rate
Mortgage charge-off and delinquency rate
Change in demand for mortgage loans
Number of new housing
Homeownership ratio
starts
Risk-weighted Tier I capital ratio
Federal Housing Administration loans volume
Change in mortgage lending standards
* Prepared by authors based on Taylor, 2007; Avery, 2011.

The period chosen for the analysis is between the first quarter of 2000 and the third
quarter of 2013, therefore, it allows capturing the causes and consequences of the crisis
from its very roots and beginning of formation until the period showing the signs of
economic recovery. The assessment of the whole cycle (rise, fall, and recovery) makes it
possible to present a wide review of the subprime mortgage crisis and provide conclusions
and proposals based on calculations.

Graphical paired regression analysis of model variables

The main purpose of the regression analysis of the dependent variable and independent
variables is to calculate and select the factors that could facilitate producing a model
which adequately reflects the relationship with the number of houses and can be used in
the calculations of the impact of changes of separate factors.
The first step towards such a model is the graphical analysis of the dependent variable
and independent variables of the model. The paired dependence of the dependent variable
on each independent variable is drawn, and different trend equations are selected,
the coefficients of determination of which determine the form of data of independent
variables, which is the best in terms of reflecting the relationship with the dependent
variable. Thus, having entered all data of variables in the time series, Appendix 3 is
produced.

97
 Data in Appendix 3, beside the Federal funds rate, are provided already slightly
modified – the best correlation with the dependent variable was of the Federal funds
effective interest rate moved over 5 quarters (correlation coefficient -0.54113), because
decisions of the central bank with respect to interest rates and their adjustment in the
economy start functioning not immediately, but with a certain time lag.
Higher values of the Federal funds rate are followed by moderately lower and negative
values of changes in the number of houses and vice versa – lower interest rates are
related to greater and positive changes in the number of houses. This consistent pattern
arises from the monetary policy pursued by the Federal Reserve Bank, the purpose of
which is to monitor inflation and other different economic indicators and adopt decisions
on the size of interest rates on their basis. Trend equations (linear and square) drawn
in Fig. 4 do not contradict the economic laws – rising Federal funds rate reduces the
number of houses, i.e. suppresses economic activity and housing demand, and housing
Dependence
supply concurrently of the number of new housing starts on the
decreases.
modified effective rate of Federal funds
50.00%
Change in the number of new housing starts

40.00%

30.00%
y = 238.15x2 - 18.971x + 0.2056
20.00%
R² = 0.4505
10.00%

0.00%
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%
-10.00%

-20.00%
y = -5.0477x + 0.1124
-30.00%
R² = 0.2975
-40.00%

-50.00%

-60.00%
Modified effective rate of Federal funds

FIG. 4. Dependence of the number of new housing starts on the modified effective rate of Federal
funds*
*Prepared by authors based on New..., 2013; Selected..., 2013.

Although the coefficient of determination (0.4505) of the square trend equation in Fig.
4 is greater than that of the linear equation (0.2975), having regard to easier interpretation
and calculations and acting on the basis of economic laws (increase of interest rates results
in the slowdown of economy and reduction of prices, and the existence of the turning
point would contradict the economic theory), the linear dependence of the number of new
housing starts on the modified effective rate of Federal funds has been chosen.
Appendix 4 reflects the relationship between the dependent variable and the mortgage
charge-off and delinquency rate. It is obvious that data are quite tendentiously distributed

98
in the descending direction, i.e. the relationship between these variables is negative –
increasing changes in mortgage charge-off and delinquency rates predetermine smaller
and negative changes in the number of new housing starts. Due to the minor difference
between the coefficients of determination (0.4903 – of the square equation, 0.4864 –
of the linear equation), the linear relationship between the dependent variable and this
independent variable is chosen for the further estimates and calculations of the model.
Such relationship between these two variables is explained by the fact that greater
changes in the mortgage charge-off and delinquency rate testify to the poor quality of
the originated loans and problems in the housing market at large, or the creation of
the housing bubble. For market participants, this signals about a higher risk and the
likelihood of crisis in this sector, thus resulting in negative expectations, avoidance of
this sector, a lower housing demand, and concurrent reduction in the number of new
housing starts. Contrarily, when the mortgage charge-off and delinquency rate fall,
market participants’ expectations become positive, and it testifies to the favourable
situation both in the mortgage loans market and in the housing market at large, and,
accordingly, the market is expected to grow further, which, in turn, encourages banks
to increase lending and market participants to borrow and invest in residential houses.
Accordingly, construction industry responds to a higher demand also by the growing
volumes of new housing starts.
Appendix 5 shows the paired regression relationship between the dependent variable
and increase in the demand for mortgage loans, reported by respondents. Although, due
to relatively short data series and period covered by analysis, the data points are rather
disorderly and widely dispersed, the trend equations defining the paired relationship
during the period under consideration still reflect the tendency of growth (the linear
equation trend coefficient is positive: 0.389). A comparison of the coefficient of
determination of the linear and square paired regression equation also does not show
any significant difference (0.3387 and 0.367, respectively); thus, like in other cases,
the linear interdependence between these two variables is chosen because of the easier
interpretation and calculations.
Although from the first sight it might seem strange why the interdependence existing
between the demand for mortgage loans and new housing starts, which is the elementary
economic law (increasing demand for loans results in a higher housing demand and
concurrently stimulates the increase of house numbers) is not very distinct in this chart,
but this question can be answered getting back to the statistical analysis of variables
and ascertaining once again that this ratio included in the calculations is not a pure
indicator of the amount or volume of demand, it is just the percentage of respondents
who have reported the increase in the demand for mortgage loans. Therefore, this ratio
shows the net percentage of banks that have faced a higher demand for mortgage loans

99
in particular quarters compared to the previous quarter; however, this ratio excludes
the loan origination volume. It means that in one quarter the demand for mortgage
loans might increase for 75% of banks and decrease for 25% of banks, so the ratio
will reach 50%, but the extent of such increase may be smaller than the reduction of
lending volumes in several banks; therefore, the interdependence between the number
of new housing starts, and the net share of respondents reporting a higher demand for
mortgage loans is not so obvious. However, as already mentioned above, the dependence
of these factors manifests the tendency of growth – the higher percentage of banks facing
a higher demand for mortgage loans predetermines a greater change in the number of
new housing starts, and the lower percentage means a smaller change in the said number.
Although this dependence does not precisely define the lending volume, it still reflects
the approximate trend of the whole market and roughly shows the volume sign (+ / –);
thus, we can see that the growing percentage of banks reporting a higher demand for
mortgage loans predetermines the increase in the number of houses.
One more analysed factor that influenced the number of new housing starts is the
tightening of mortgage lending standards. Paired dependence curves (Appendix 6)
also show no contradictions to economic laws and economic logic in the relationship
between the tightening of mortgage lending standards and the number of new housing
starts during the reference period – the easing or slight tightening of the mortgage lending
standards is followed by considerably higher values of the number of new housing starts,
and greater tightening of the standards is related to an immediately smaller and in many
cases negative change in the number of new housing starts. It is so because the easing
of lending standards predetermines a larger volume and number of the originated loans
– loans can be obtained both by lower-income individuals, borrowers who already have
taken one or more loans, as well as individuals whose credit rating is insufficient when
more stringent requirements apply. In that way, the larger amount and volume of the
originated mortgage loans stimulates housing purchases and demand, which, in its turn,
also increases the number of new housing starts. The tightening of mortgage lending
standards, contrarily, narrows the number of individuals who are eligible and have
the possibility to apply for mortgage loans, because the increasingly smaller share of
potential borrowers meet the imposed tighter requirements, so the volume and number of
the originated loans reduces as the mortgage lending standards become tighter, which in
its turn also reduces the housing supply. As the coefficients of determination of the square
and linear paired regression equation are practically the same (0.4948 and 0.4947), the
model again uses the data provided in Appendix 3 without any modifications or changes.
Appendix 7 depicts the paired regression relationship between one more significant
independent variable – the risk-weighted Tier I capital ratio of banks and the dependent
variable. We can see that the dispersion of data is relatively great, and data points are

100
arranged in accidental order, without showing any obvious consistent pattern. However,
after drawing the trend equations, we still have a negative slope which, due to a high data
dispersion, is rather small. In other words, when the capital ratio significantly increases, the
reduction of the dependent variable is quite inconsiderable. It is so because the bank capital,
as a rule, is subject to the ongoing supervision and various established capital adequacy
ratios, thus, the risk-weighted Tier I capital of banks may not fall below the established
threshold of 4%. Many banks are trying to exceed this ratio, so they usually do not reach this
threshold and maintain a secure “reserve” which changes only inconsiderably; however,
banks avoid keeping this reserve excessively large, because they have to pay interest or
dividends on (own or borrowed) capital, and its employment for minimum return is too
expensive and can be loss-making. This stimulates banks to seek the maximum advantage
of the possibilities of risks taken by them. Therefore, when the economy surges, banks,
considering positive expectations of economic growth and situation, tend to take a higher
risk and originate more loans, which increases housing demand and, concurrently, supply.
When the economy stagnates, banks, again, act pro-cyclically and, because of uncertainty
of economic forecasts and worsening expectations, tend to accumulate an additional capital
reserve to cover potential losses, minimise risks taken by them, tighten lending standards
and volumes, which, in turn, reduces housing demand and construction volumes. Due to
the minor difference between the coefficients of determination (square – 0.0624, linear
– 0.0318), the linear interrelationship of the factors is chosen; however, in addition to
Appendix 7, the coefficients of determination also imply that the impact of Tier I capital
ratio on housing numbers is minor and very insignificant.
The next variable covered by the regression analysis is the homeownership ratio. The
development of this ratio in paired regression with the number of new housing starts does not
require any additional modifications as the trend curves (Appendix 8) and the coefficients
of determination (linear – 0.0057, square – 0.0114) show that the interrelationship of these
two ratios, reflected by the linear trend equation, is essentially similar to the square trend
equation; therefore, the linear relationship between these ratios is again chosen, because
it favours easy calculations and the interpretation of the obtained results. The positive
coefficient of relationship shows that when the homeownership ratio increases, the number
of new housing starts also has the tendency to increase. To put it otherwise, the increasing
homeownership ratio shows that the percentage of houses purchased and occupied by
owners keeps growing; therefore, it is obvious that, due to that, housing demand and
supply increase. As already mentioned above in this paper, the homeownership support
programmes implemented by the government only partially justified the expectations – the
bigger part of homes were acquired by individuals who were purchasing not their first
home, and the homeownership ratio, therefore, reflects a considerably lower percentage
of increase than actually was, but the relationship between these factors, albeit weak, still

101
exists. However, likewise in the case of Tier I capital ratio, it can be assumed that the
relationship may be statistically insignificant, which is also indicated by a completely
accidental distribution of points in Appendix 8 and a high data dispersion. In other words,
it is quite difficult to identify a distinct tendency of the dependent variable’s response to the
developments of the independent variable on the basis of available data.
Appendix 9 presents the interdependence between the number of new housing starts
and the volume of mortgages insured by FHA. The distribution of data is rather uneven:
the concentration of different values of changes in housing numbers can be observed both
where the volume of mortgages insured by FHA is small and large. The slope produced
drawing a square and a linear regression equation of the interdependence of these factors
is negative (-0.0013 in the linear equation). Like for all other paired regression equations
of the dependence of factors, in this case out of the two the linear relationship is chosen,
although the difference between the coefficients of determination in this case is quite
significant (square – 0.2909, linear – 0.0222). However, the data series is rather short,
and the coefficient of determination of the square equation is to a great extent increased
by extreme values. Furthermore, the existence of the turning point is also logically
incompatible with the economic theory; therefore, the linear relationship between these
factors is chosen to facilitate the calculations and interpretation. Such a distribution of the
negative slope data can be explained by the relationship which exists between the smaller
volume of loans insured by FHA and the FHA’s role of providing liquidity support to the
mortgage market. During periods of the economic upswing, loans and lending volumes
of other market players due to the pro-cyclical lending policy pursued by banks grow
significantly, thus reducing the market share and lending volumes of FHA and considerably
increasing housing numbers due to the growth of housing demand and home purchases.
In the periods of economic downturn, the number and volumes of bank loans begins
to contract gradually, and lending standards are significantly tightened, resulting in the
increase of market share and lending volumes of FHA, which continues originating the
same loans of sufficiently good quality in support of liquidity, while the entire housing
market at that time is contracting, also bringing down the housing demand and supply. It
follows from the above that such interpretation and distribution of points in Appendix 9
shows that the interrelationship between these factors might be insignificant, because the
data are too scattered, and the volume of loans insured by FHA might be a result of other
independent factors and indicators.

Multiple regression analysis

A multiple regression model of the dependent variable and independent variables is
produced using all data series of the relationship between the dependent variable and
independent variables covered by the paired regression analysis. Given the linear

102
relationship existing in this case between all independent variables and the number of
new housing starts, no modifications are made in the data table, and calculations are
carried out using the same Appendix 3. It’s just worth mentioning again that instead of
the Federal funds rate the Federal funds rate carried forward for 1.25 years is used, but
the relationship is still linear.
An important aspect in producing the regression model is to determine the
multicollinearity. The existence of multicollinearity in the model being produced in
this case would mean a correlation between one or more independent variables of the
model, i.e. one variable can be obtained linearly from other variables with a sufficiently
high level of accuracy. In that case, any small changes in the model or data can bring
about significant and variable changes in the calculated multiple regression coefficients,
and the signs of the coefficients may be incompatible with economic laws. The
multicollinearity itself does not reduce the reliability and accuracy of the entire model,
but it affects the calculation of separate variables of the model. It means that the multiple
regression model with correlating variables can show with what accuracy and precision
all independent variables predict the dependent variable, but the model cannot produce
any particular results related to separate independent variables of the model or identify
the variable which is insignificant. Given that the purpose of producing this multiple
regression model is to assess the impact of separate factors and to calculate on its basis
the results of alternative actions of the central bank and the government, the next step
in this study is to verify whether the multicollinearity of the model exists, and if it does
exist – to eliminate it by removing closely interrelated independent variables.
For the purpose of assessing the multicollinearity, the table of paired correlation
coefficients is used. Although quite often a “rule of thumb” is used, according to which a
model is considered to be multicollinear when the paired correlation coefficient module
is greater than 0.8, however, in order to calculate the coefficients of the model with
the maximum accuracy, in other stages this threshold is reduced to 0.7. The data of
paired correlation coefficients are presented in Table 3. The yellow column shows the
correlation coefficients of the dependent variable and independent variables, thus it is not
taken into account when assessing the multicollinearity of the model. As we can see, the
coefficient is greater than 0.7 only in one case of paired correlation (marked in red in the
Table) – between the mortgage charge-off and delinquency rate and the net percentage
share of banks that have tightened mortgage lending terms. For the purpose of examining
which of these factors should be eliminated, other correlation coefficients are considered.
As the correlation of both factors with the dependent variable is essentially the same and
the ratio of tightening mortgage lending terms is more related to the residual independent
variables, this factor is eliminated from the model.

103
 TABLE 3. Paired correlation coefficients of regression variables

104
Net percentage Net percentage
Mortgage Volume of
Modified share of share of respondent
charge- Risk-weighted Home- loans insured
Number of new effective respondent banks, banks, tightening
  off and Tier I capital ownership by Federal
housing starts Federal funds reporting higher mortgage
delinquency ratio rate Housing
rate demand for underwriting
rate Administration
mortgage loans standards

Number of new housing starts 1              

Modified effective Federal funds

-0.545459998 1            
rate
Mortgage charge-off and
-0.697422904 0.39153705 1          
delinquency rate
Net percentage share of respondent
banks, reporting higher demand for 0.581982172 -0.196919902 -0.328274809 1        
mortgage loans

Risk-weighted Tier I capital ratio -0.178378582 0.092095953 0.339578764 -0.272314915 1      

Homeownership rate 0.075420517 0.108840919 -0.079543376 0.232735079 -0.149472854 1    

Volume of loans insured by Federal

-0.148920211 -0.189820144 0.293783563 0.131845193 0.295782417 -0.123085999 1  
Housing Administration
Net percentage share of respondent
banks, tightening mortgage -0.703381497 0.38325213 0.713196585 -0.384287973 0.244943833 -0.193220708 0.471929955 1
underwriting standards

Prepared by authors based on New..., 2013; Selected..., 2013; Senior..., 2013; Seasonally..., 2013; Charge-off..., 2013; BHCPR..., 2013; FHA..., 2013)
 In order to make an even deeper assessment of multicollinearity between the residual
factors, VIF statistics is used:
1
1 ���(�� ) =
���(�� ) = , 1 − ���
1 − ���
where Xj is the j-th independent variable, ��� is the coefficient of determination of the
���
j-th independent variable regression equation with other independent variables. Some
authors suggest in their works that multicollinearity of a model exists when VIF (Xj) >
1 1
5 and others
1 when 1VIF (X���(�
j)1,36
> 10.
� ) =Given �that
= the present= paper
1,36 analyses the economic
���(�� ) = � = = 1 − �� 1 − 0,2682
variables
1 − �that
� 1 −interrelated
are 0,2682 in one way or another and depend on the general economic
situation, in order to achieve a better clarity of variables of the model and 1
to calculate more
precise and undistorted data, the lower1 VIF statistics 1 ���(�
measure� ) =is used,
� i.e. considering
1 −1��
1 1 ���(�� ) = � = 1 − 0,3925 = 1,65
� ) =multicollinearity
���(�that � = 1 − 0,3925
of = 1,65
the model 1 − �when
exists � VIF (X ) > 5.
���(� � ) =
1−� j �
� �
�� 1 − ��
1 1
1 1 ���(� )= = = 1,35� �
���(�TABLE
�) =
4. VIF statistics
= calculations
= 1,35of �independent
1 − ��� variables of the model
1 − 0,261 �
1 − ��� 1 − 0,261
Independent variable 1 1 1 statistics1value
VIF
1 1 ���(�� ) = = ���(�� ) = 1 = � = 1 − 0,2682 = 1,36
1,11
���(�� ) = � = 1 − 0,0988 = 1,11 1 − �� 1 − 0,0988 1��
� −
1
1 − effective
Modified �� Federal funds rate ���(�� ) = = = 1,36
1 − ��� 1 − 0,2682
1 1
1 1 ���(� ) = = = 1,27
���(�� ) = � = 1 − 0,2134 = 1,27� 1 − ��� 1 − 0,2134 1 =
���(�� ) =
1
= 1,65
Mortgage
1 − ��charge-off and delinquency rate
1 − ��� 1 − 0,3925
1 1 )= 1 1
1 1 ���(�� ) = ���(� = = 1,65
� = 1 − 0,3062 1=− 11,44
�
) = in demand
���(��Change = = 1,44 ��� 1 − 0,3925
1
� for mortgage loans 1 − �� ���(� � )= = = 1,35
1 − �� 1 − 0,3062 �
1 − �� 1 − 0,261
1 1
���(�� ) = = = 1,35
11− ��� 1 −10,261
Homeownership rate ���(�� ) = � = 1 − 0,0988 = 1,11
� = −2,69811 � � − 13,02445 � � + 0,24955 � �� + 0,10301 1 − ��
1 1
13,02445 � �� + 0,24955 � ��� + 0,10301 � ���(�� ) = = = 1,11
1− 1 ��� 1 − 0,0988
1
Risk-weighted Tier I capital ratio ���(�� ) = � = 1 − 0,2134 = 1,27
1 − ��
� � 1 1
� � ����������� � �������������������������
���(�� ) = � = 1 − 0,2134 = 1,27
����������� � ������������������������� 1
1 − �� 1
Federal Housing Administration lending volume ���(�� ) = = = 1,44
1 − ��� 1 − 0,3062
1 1
���(�� ) = = = 1,44
1 − ��� 1 − 0,3062
Prepared by authors based on New..., 2013; Selected..., 2013; Senior..., 2013; Seasonally..., 2013; Charge-
off..., 2013; BHCPR..., 2013;
� = FHA..., 2013. � � − 13,02445 � � + 0,24955 � � + 0,10301
−2,69811 � � �

� = −2,69811 � �� − 13,02445 � �� + 0,24955 � �� + 0,10301

As the calculated VIF statistics (Table 4) shows � that the linear
� relationship between
����������� � �������������������������
all six independent variables and the residual �independent� variables is very weak,
����������� � �������������������������
the independent variables are not eliminated. Considering both the matrix of paired
correlations and VIF statistics values that are relatively small and don’t reach even the
value of 2, it can be concluded that having eliminated the tightening of mortgage lending
standards from the list of independent variables, the model with the residual factors is
no longer multicollinear, and thus the calculation results are not distorted. Furthermore,
the effect of the eliminated factor is not lost to a certain extent, because it was mainly the

105
result of the residual independent variables which are related to the eliminated variable
and will continue influencing the dependent variable of the model.
The multiple regression equation coefficients are calculated for all residual
independent variables. As part of the factors have been eliminated, the residual ones are
marked as follows:
• Y – the number of new housing starts, percentage change compared to the last
year’s quarter (dependent variable);
• X1 – the modified effective Federal funds rate (1.25 years time lag); X2 – the
mortgage charge-off and delinquency rate of 100 largest banks, absolute change
compared to the previous quarter; X3 – the net percentage share of banks reporting
a higher demand for mortgage loans; X4 – the risk-weighted Tier I capital ratio,
the percentage change compared to the previous quarter; X5 – the homeownership
ratio, percentage change compared to the previous quarter; X6 – the volume of
loans insured by the Federal Housing Administration, USD billion.
In order to assess the impact of each independent variable on the dependent variable,
the statistical significance of each factor is examined using t statistics (see Appendix 10)
showing the independent variables of the model that should be included in the model at the
particular confidence level. If |t calculated| > t notional, and null hypothesis is eliminated,
the impact of the independent variable is statistically significant. As the model seeks the
maximum accuracy, the confidence level chosen in this case is 99 %, and the notional
value t is 2.6822 (Appendix 10, upper highlighted boxes, using TINV function). Having
eliminated the homeownership ratio from the regression model, the same procedure is
repeated until the modulus of t statistics of all residual factors becomes greater than the
notional value t of the confidence level of 99 %. The risk-weighted Tier I capital ratio and
the volume of loans insured by FHA appeared to be statistically insignificant, which to a
certain extent was also shown by the previous paired regression analysis.
Therefore, having calculated and assessed the impact of separate three residual
independent variables of regression on the dependent variable, the equation coefficients
are obtained (column Coefficients in the lower part of Table 5). The final calculated
regression equation is as follows:

Y = –2.69811 · X1 – 13.02445 · X2 + 0.24955 · X3 + 0.10301.

The relationship between the independent variables and the dependent variable in the
paired regression analysis and the slope in the multiple regression equation is confirmed, i.e.
the increase of the modified Federal funds rate and mortgage charge-off and delinquency
rate reduces the number of new housing starts, and the increase in the percentage share of
respondent banks reporting a higher demand for mortgage loans increases the number of
new housing starts. The graphical paired analysis of variables also produced analogous

106
TABLE 5. Results of calculations of the final regression equation

SUMMARY OUTPUT
Regression statistics
Multiple R 0.835233692
R Square 0.697615319
Adjusted R square 0.679827985
Standard error 0.1126636 F-distribution value = 4.190618788
Observations 55
ANOVA
  df SS MS F Significance F
Regression 3 1.493460187 0.497820062 39.21977929 2.76454E-13
Residual 51 0.647347426 0.012693087
Total 54 2.140807613      
Standard
Coefficients t Stat P-value Lower 95% Upper 95%
  Error
Intercept 0.103011612 0.025059616 4.110662092 0.000143479 0.052702335 0.153320889
Modified effective rate of
Federal Funds, time lag of -2.698110366 0.776807609 -3.473331536 0.001057084 -4.257616681 -1.13860405
5 quarters, %
Mortgage charge-off and
delinquency rate of 100
largest banks, absolute -13.0244469 2.463088322 -5.287852158 2.60941E-06 -17.96930294 -8.079590863
change compared to the
previous quarter, %
Net percentage share of
banks, reporting higher
0.249545473 0.054659102 4.56548797 3.17442E-05 0.139812749 0.359278197
demand for mortgage
loans, %

Prepared by authors based on New..., 2013; Selected..., 2013; Charge-off..., 2013; Senior..., 2013.

results. The coefficient values as such do not say much about the strength of the impact on
the dependent variable, because they depend not only on the strength of the relationship, but
also on the limits of change of the analysed period and measurement units – the modulus
value of the trend coefficient of the independent variable, which changes significantly and
frequently, producing high values which will always be lower than the variable which is
more stable and changes less frequently or develops lower values.
The coefficient of determination (line R Square in the upper part of Table 5) is
0.697615319, so it can be stated that the regression equation explains almost 70% of
dispersal of the dependent variable’s values around the mean; thus, generally speaking,
the produced model sufficiently accurately defines the dependence of the number of new
housing starts on the independent variables included in the model, which can be directly
influenced by the central bank and the country’s government. The strength of the linear
relationship between the dependent variable and independent variables is also testified
by the multiple correlation coefficient (line Multiple R in the upper part of Table 5),
which is 0.835233692. According to the general “rule of thumb”, the closer its value is
to 1 the stronger is the relationship, and when it exceeds 0.8 the relationship between

107
model variables is considered to be strong. The examination of statistical significance
of the whole regression is also an important step in assessing the calculated regression.
The calculated value of F statistics (intersection of line Regression and column F
in the middle part of Table 5), which is used, is 39.21977. The calculated actual value
of F statistics is compared with the notional Fa; k; n-k-1 value of the chosen confidence
level (in this case, the selected significance is also 99%, a = 0.01) from F-distribution
tables, where k is the number of independent variables of the model and n is the total
number of observations. Thus, in this case, F0.01; 3; 51 = 4.19 (column 1
F-distribution
���(� �) =
value in the middle part of Table 5, used function – FINV), whereas Fcalculated 1 − �>�� F
0.01; 3; 51
(39.21977 > 4.19), the null hypothesis that the regression is statistically � insignificant at
��
the 99% confidence level is refuted, and the alternative that the impact of at least one
independent variable on the dependent variable is statistically significant is accepted.
Consequently, the produced regression model is statistically 1
significant. 1
���(�� ) = � = 1 − 0,2682 = 1,36
All three residual plots in Appendix 11 show that errors are 1 − �� quite accidental –

both positive and negative error values are distributed sufficiently evenly and more
or less equally. Such an accidental distribution shows that the 1linear regression 1 model
���(�
adequately reflects the impact of data, while the nonlinear ) =
� model would = better=when
1,65
1 − ��� 1 suit− 0,3925
the distribution of errors is more U-shaped or upside-down U-shaped or takes any other
1 1
form (Residual..., 2013). ���(�� ) = � = 1 − 0,261 = 1,35
1 − ��
To test for heteroscedasticity, the White test is applied making calculations with the
1 1
help of the Eviews programme (see Appendix 12). A���(� model� ) is
= heteroscedastic when it has
� = 1 − 0,0988 = 1,11
1 − ��
a varying error dispersion, i.e. dispersion of certain errors differs from dispersion of other
errors. Heteroscedasticity does not move the regression 1 calculated 1 using the
���(�coefficients
�) = � = 1 − 0,2134 = 1,27
ordinary least squares approach, but it moves standard errors of1 the − �model
� above or below
the actual values. Due to that, the confidence intervals and tests1of hypotheses 1 generate
���(�� ) = � = 1 − 0,3062 = 1,44
1 −
unreliable results, thus in the case of the heteroscedastic model the null �� hypothesis can be
accepted at a certain confidence level, although actually it should be refuted.
The results of the White test calculations carried out using the Eviews programme are
� = −2,69811 � �� − 13,02445 � �� + 0,24955 � �� + 0,10301
presented in Appendix 12. As the calculated value of the chi-square is 7.331295 (Appendix
12, top line Obs*R-squared) and the notional chi-square value at the 95% confidence
� �
level and 9 degrees of freedom is 16.919, then ����������� � ������������������������� .
Thus, at the 95% confidence level, the null hypothesis is accepted (α2 = α3 = α4 = α5 =
α6 = α7 = α8 = α9 = α10 = 0), and it can be concluded that the regression model produced
is not heteroscedastic.

Conclusions
In summarising the views, theories, arguments, evidence, and considerations of
economists and researchers about the causes and factors of the U.S. subprime mortgage
crisis of 2007–2008 in the review of literature, the following conclusions were drawn:

108
1. Income and growth were excessively highlighted, with too little attention devoted to
the risks and risk volumes on the part of both the private and the public sectors. The
concentration of banks on growth was motivated by competition and investments
in the markets of mortgages and securities comprising them. Seeing a too wide
competitive gap in the sphere of fixed-income securities, the majority of banks
focused their resources towards the growing markets of asset-backed securities,
mortgage securities, and adjustable-rate mortgages, which were considered to offer
huge possibilities for income growth.
2. Nobody cared about analysing in detail the strategy of banks and its risks. Overreliance
of risk management and control on credit ratings assigned by rating agencies
prevented it from predicting and analysing the credit risk of mortgage securities.
3. Financial institutions relied too much on the quantitative methods of analysis, stress
tests and statistical risk assessment models based on the data of a few last years.
At the same time, the correlation between the risk of securitization and the risk of
securities held in balance sheets of banks was ignored.
4. The majority of financial market participants devoted insufficient attention to the
systemic risks, such as reduction of liquidity in certain markets or the drop of housing
prices.
5. The new information about growing default indicators or the dependence of results of
the mortgage securities market on the U.S. housing market at large has not been taken
into account.
6. Risk incentives of financial institutions were inadequate: higher-yielding investments
in riskier securities or other financial instruments were stimulated by huge bonuses
and payments, disregarding the long-term impact of taken risks; the change of a
more effective and expensive risk insurance scheme by a cheaper and less effective
insurance scheme was generously rewarded.
Summing up the research of the causes and consequences of the U.S. subprime
mortgage crisis of 2007–2008, conducted by the authors, the following conclusions were
drawn:
1. The performed statistical and paired regression analysis of the independent variables
and the number of new housing starts at the beginning of the research has shown that the
Federal Reserve Bank has deliberately replaced the “dot-com” bubble by the housing
bubble, by increasing money supply and keeping low interest rates for an extended
period. It was further concluded that until 2007 the housing schemes had too actively
promoted lending to lower-income individuals, and due to that mortgage default rates
increased, and the housing construction volumes and prices started falling.
2. Upon calculating and assessing multiple regression equations and different statistical
coefficients of significance and determination, it was concluded that the subprime

109
 mortgage crisis and housing bubble was not an isolated and independent event. It
was a result of a parallel functioning of several factors, the sources of which stretch
not only to the risky activities of the private sector but also to the imprudent policy
of the Federal Reserve Bank, the actively pursued housing support policy and the
inadequate control of financial institutions.
3. After systematising the available data and indicators, the model of dependence of
new housing starts on the factors which were directly and significantly affected by
the central bank and the policy of the government, was produced. With the help of
this model, it was established that housing numbers in the model were influenced by
the Federal funds rate, the growing demand for mortgage loans, and the mortgage
charge-off and delinquency rate.

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APPENDICES

APPENDIX 1. U.S. homeownership rates in 1998–2007 (Census ..., 2007)

Homeownership Ratesa
Year
First Quarter Second Quarter Third Quarter Fourth Quarter
2007 . . . . . . . . . . . . . . 68.4 68.2 68.2
2006 . . . . . . . . . . . . . . 38.5 68.7 69.0 68.9
2005 . . . . . . . . . . . . . . 69.1 68.6 38.8 69.0
2004 . . . . . . . . . . . . . . 68.6 69.2 69.0 69.2
2003 . . . . . . . . . . . . . . 68.0 68.0 68.4 68.6
2002b . . . . . . . . . . . . . . 67.8 37.6 38.0 68.3

2002 . . . . . . . . . . . . . . 67.8 67.6 68.0 68.3

2001 . . . . . . . . . . . . . . 67.5 67.7 68.1 68.0
2000 . . . . . . . . . . . . . . 67.1 67.2 67.7 67.5
1999 . . . . . . . . . . . . . . 66.7 66.6 67.0 66.9
1998 . . . . . . . . . . . . . . 65.9 66.0 66.8 66.4

1994 . . . . . . . . . . . . . . 63.8 63.8 64.1 64.2

APPENDIX 2. Distribution of mortgage loans by type in 1995–2006 (Kiff et al., 2007)

4000 4000
(billion U.S. dollars)
3500 3500
FHA/VA
3000 Conforming 3000
Prime Jumbo
2500 Alt A 2500
Subprime
2000 2000

1500 1500

1000 1000

500 500

0 0
1995 1997 1999 2001 2003 2005

112
APPENDIX 3. Regression variables and their data, 2000-2013

change compared to the

change compared to the

Number of new housing

Administration, bill. USD

capital ratio, percentage

Volume of loans insured

underwriting standards,
Net percentage share of
banks, absolute change

banks, reporting higher

Mortgage delinquency

Federal Funds effective

corresponding quarter

Modified effective rate

of the previous year, %

demand for mortgage

of Federal Funds, time

Homeownership rate,

Net percentage share

Risk-weighted Tier 1

of banks, tightening
percentage change
previous quarter, %

previous quarter, %

previous quarter, %

by Federal Housing
lag of 5 quarters, %
starts, percentage

rate of 100 largest

compared to the

compared to the
Quarters

loans, %

rate, %
%
2000 Q1 -1.98% 4.75% -0.19% -63.5% 1.84% 0.30% 19.1 -1.9% 5.75%
2000 Q2 0.34% 4.75% -0.10% -42.6% 1.90% 0.15% 24.6 -5.6% 6.25%
2000 Q3 -9.08% 4.75% 0.22% -39.7% 3.62% 0.74% 22.9 0.0% 6.50%
2000 Q4 -6.88% 5.00% 0.46% -32.7% 0.00% -0.30% 21.4 0.0% 6.50%
2001 Q1 -2.60% 5.25% -0.24% 0.0% -2.85% 0.00% 33.0 0.0% 5.50%
2001 Q2 2.63% 5.75% 0.07% 46.1% 1.90% 0.30% 42.5 3.8% 4.25%
2001 Q3 5.90% 6.25% 0.23% 24.5% 3.62% 0.59% 39.5 3.8% 3.50%
2001 Q4 2.21% 6.50% -0.15% -1.9% 0.00% -0.15% 36.9 3.8% 2.25%
2002 Q1 6.10% 6.50% -0.21% 28.9% 1.48% -0.29% 30.4 1.9% 1.75%
2002 Q2 3.06% 5.50% -0.17% 5.6% 1.56% -0.29% 39.2 1.9% 1.75%
2002 Q3 6.83% 4.25% -0.04% 27.5% 0.10% 0.59% 36.4 3.9% 1.75%
2002 Q4 10.26% 3.50% 0.00% 40.0% -0.82% 0.44% 34.0 10.0% 1.50%
2003 Q1 1.54% 2.25% -0.19% 7.4% 1.03% -0.44% 36.0 11.1% 1.25%
2003 Q2 3.39% 1.75% -0.22% 17.0% 0.82% 0.00% 46.0 5.7% 1.25%
2003 Q3 11.43% 1.75% -0.12% 46.3% 0.10% 0.59% 43.0 1.9% 1.00%
2003 Q4 17.00% 1.75% 0.56% -18.6% 1.93% 0.29% 28.0 0.0% 1.00%
2004 Q1 13.34% 1.50% -0.59% -38.5% 5.97% 0.00% 24.0 -1.9% 1.00%
2004 Q2 9.92% 1.25% -0.13% -5.8% -6.95% 0.87% 25.0 -7.8% 1.00%
2004 Q3 4.11% 1.25% 0.03% -7.7% -0.50% -0.29% 19.0 -5.8% 1.50%
2004 Q4 -2.50% 1.00% -0.06% -24.5% 1.83% 0.29% 16.0 1.9% 2.00%
2005 Q1 5.53% 1.00% -0.14% -27.5% -1.89% -0.14% 14.0 -7.8% 2.50%
2005 Q2 6.66% 1.00% 0.11% -18.3% 0.41% -0.72% 16.0 -2.1% 3.00%
2005 Q3 6.69% 1.00% 0.08% 20.4% -2.73% 0.29% 15.0 0.0% 3.50%
2005 Q4 3.81% 1.50% 0.27% -22.2% 0.10% 0.29% 12.0 -3.7% 4.00%
2006 Q1 3.53% 2.00% -0.22% -44.0% -1.66% -0.72% 13.0 0.0% 4.50%
2006 Q2 -9.46% 2.50% -0.04% -23.1% 1.48% 0.29% 16.0 -9.4% 5.00%
2006 Q3 -19.33% 3.00% 0.22% -58.5% -0.52% 0.44% 14.0 -9.3% 5.25%
2006 Q4 -24.92% 3.50% 0.46% -60.4% 1.57% -0.14% 13.0 1.9% 5.25%
2007 Q1 -30.63% 4.00% -0.11% -37.0% -2.68% -0.73% 12.0 16.4% 5.25%
2007 Q2 -21.31% 4.50% 0.22% -15.9% -0.74% -0.29% 18.0 45.5% 5.25%
2007 Q3 -23.42% 5.00% 0.69% -21.3% -0.21% 0.00% 20.0 40.5% 5.00%
2007 Q4 -23.87% 5.25% 0.83% -45.0% -3.95% -0.59% 27.0 60.0% 4.50%
2008 Q1 -28.11% 5.25% 0.89% -69.2% -1.56% 0.00% 38.0 84.6% 3.25%
2008 Q2 -30.79% 5.25% 0.95% -29.7% 3.16% 0.44% 66.0 75.6% 2.00%
2008 Q3 -32.40% 5.25% 1.34% -46.9% -1.10% -0.29% 73.0 84.4% 2.00%
2008 Q4 -43.75% 5.00% 2.41% -72.4% 15.39% -0.59% 67.0 89.7% 0.50%
2009 Q1 -50.56% 4.50% 1.25% -64.0% 3.93% -0.30% 78.0 48.0% 0.25%
2009 Q2 -45.79% 3.25% 0.97% -12.0% -1.29% 0.15% 100.0 64.0% 0.25%
2009 Q3 -31.52% 2.00% 1.51% -16.7% 2.43% 0.30% 89.0 45.8% 0.25%
2009 Q4 -19.56% 2.00% 2.08% -4.3% 4.57% -0.59% 90.0 30.4% 0.00%
2010 Q1 17.40% 0.50% 0.06% -35.3% 6.99% -0.15% 56.0 29.4% 0.25%
2010 Q2 11.83% 0.25% -1.09% -33.3% 4.65% -0.30% 78.0 4.8% 0.25%
2010 Q3 -0.92% 0.25% -0.22% 0.0% 1.72% 0.00% 68.0 4.5% 0.25%
2010 Q4 -2.92% 0.25% -0.31% -9.5% -0.54% -0.60% 67.0 9.5% 0.25%
2011 Q1 -6.55% 0.00% -0.28% -13.0% 1.23% -0.15% 47.0 13.0% 0.25%
2011 Q2 -4.94% 0.25% -0.24% -23.8% 1.07% -0.75% 48.7 10.0% 0.00%
2011 Q3 6.28% 0.25% -0.16% -12.5% -0.98% 0.61% 46.3 -4.2% 0.00%
2011 Q4 24.29% 0.25% 0.06% 4.5% 0.84% -0.45% 46.1 0.0% 0.00%
2012 Q1 23.43% 0.25% -0.01% -4.3% 3.09% -0.91% 47.0 4.3% 0.00%
2012 Q2 28.01% 0.25% -0.29% 23.1% -2.71% 0.15% 59.7 11.5% 0.25%
2012 Q3 25.22% 0.00% 1.07% 37.0% -0.53% 0.00% 62.8 11.1% 0.25%
2012 Q4 35.93% 0.00% -1.35% 12.5% -2.72% -0.15% 62.9 0.0% 0.25%
2013 Q1 34.34% 0.00% -0.68% 0.0% 1.17% -0.61% 58.3 2.9% 0.25%
2013 Q2 16.67% 0.00% -0.78% 0.0% 0.38% 0.00% 62.0 0.0% 0.00%
2013 Q3 13.46% 0.25% -0.95% 3.1% 1.07% 0.46% 45.0 -6.3% 0.00%
Prepared by authors based on New..., 2013; Selected..., 2013; Senior..., 2013; Seasonally..., 2013; Charge-
off..., 2013; BHCPR..., 2013; FHA..., 2013.

113
 Dependence of the number of new housing starts on the
mortgage charge-off and delinquency rate
Change in the number of new housing starts 50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
-2.00% -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00%
-10.00%
-20.00%
y = 155.77x2 - 21.235x + 0.0016
-30.00%
R² = 0.4903
-40.00%
-50.00% y = -19.716x + 0.0073
R² = 0.4864
-60.00%
Mortgage charge-off and delinquency rate, change compared to the previous quarter

APPENDIX 4. Dependence of the number of new housing starts on the mortgage charge-off and
delinquency rate
Prepared by authors based on New..., 2013; Charge-off..., 2013.
Dependence of the number of new housing starts on the
reported higher demand for mortgage loans
50.00%
Change in the number of new housing starts

40.00%
y = 0.389x + 0.0327
30.00%
R² = 0.3387
20.00%
10.00%
0.00%
-80.0% -60.0% -40.0% -20.0% 0.0% 20.0% 40.0% 60.0%
-10.00%
-20.00% y= -0.3162x2+ 0.3076x + 0.055
R² = 0.367
-30.00%
-40.00%
-50.00%
-60.00%
Net percentage share of banks, reporting higher demand for mortgage loans

APPENDIX 5. Dependence of the number of new housing starts on the reported higher demand for
mortgage loans
Prepared by authors based on New..., 2013; Senior..., 2013.

114
 Dependence of the number of new housing starts on the
tightening of mortgage lending standards
Change in the number of new housing starts 50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
-20,0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0%
-10.00%
-20.00% y = -0.0145x2 - 0.528x + 0.0549
R² = 0.4948
-30.00%
-40.00% y = -0.5384x + 0.0551
R² = 0.4947
-50.00%
-60.00%
Net percentage share of banks, tightening underwriting standards

APPENDIX 6. Dependence of the number of new housing starts on the tightening of mortgage lending
standards
Prepared by authors based on New..., 2013; Senior..., 2013.
Dependence of the number of new housing starts on the
risk-weighted Tier I capital ratio
50.00%
Change in the number of new housing starts

40.00%
30.00%
20.00%
10.00%
0.,00%
-10,00% -5.00% 0.00% 5.00% 10.00% 15.00% 20.00%
-10.00%
-20.00% y = -1.1162x - 0.0111
R² = 0.0318
-30.00%
-40.00% y = -13.964x2 - 0.1767x - 0.0041
R² = 0.0624
-50.00%
-60.00%
Risk-weighted Tier I capital ratio, change compared to the previous quarter

APPENDIX 7. Dependence of the number of new housing starts on the risk-weighted Tier I capital ratio
Prepared by authors based on New..., 2013; BHCPR..., 2013.

115
 Dependence of the number of new housing starts on the
homeownership rate
50.00%
40.00%
Change in the number of new housing starts

30.00%
y = 736.79x2 + 4.0796x - 0.0324
20.00%
R² = 0.0114
10.00%
0.00%
-1.00% -0.80% -0.60% -0.40% -0.20% 0.00% 0.20% 0.40% 0.60% 0.80% 1.00%
-10.00%
y = 3.4646x - 0.019
-20.00% R² = 0.0057

-30.00%
-40.00%
-50.00%
-60.00%
Homeownership rate, change compared to the previous quarter

APPENDIX 8. Dependence of the number of new housing starts on the homeownership rate
Prepared by authors based on New..., 2013; Seasonally..., 2013.
Dependence of the number of new housing starts on the
volume of loans insured by FHA
50.00%
Change in the number of new housing starts

40.00%
30.00%
20.00%
10.00%
0.00%
0.0 20.0 40.0 60.0 80.0 100.0 120.0
-10.00%
-20.00% y = -0.0013x + 0.0326
R² = 0.0222
-30.00%
-40.00%
-50.00% y = -0.0002x2 + 0.0164x - 0.2896
-60.00% R² = 0.2909
Volume of loans insured by the Federal Housing Administration, bill. USD

APPENDIX 9. Dependence of the number of new housing starts on the volume of loans insured by FHA
Prepared by authors based on New..., 2013; FHA..., 2013.

116
APPENDIX 10. Regression equation calculation results

SUMMARY OUTPUT
Regression statistics

Multiple R 0.861263309

R square 0.741774487
Adjusted R square 0.709496298 t-distribution value = 2.682204027
Standard error 0.107316815
Observations 55
ANOVA
  df SS MS F Significance F

Regression 6 1.587996469 0.264666078 22.9806723 1.42067E-12

Residual 48 0.552811144 0.011516899

Total 54 2.140807613      

  Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 0.18787908 0.044748829 4.198525064 0.000115628 0.097905531 0.27785263

Modified effective rate of
Federal Funds, time lag of 5 -3.215419553 0.793464836 -4.052378137 0.00018464 -4.810787503 -1.620051604
quarters, %
Mortgage charge-off and
delinquency rate of 100
largest banks, absolute -11.60068789 2.660261195 -4.360732665 6.82882E-05 -16.94950142 -6.251874363
change compared to the
previous quarter, %
Net percentage share of
banks, reporting higher
0.308060109 0.057033307 5.401407065 2.02911E-06 0.193386961 0.422733257
demand for mortgage
loans, %
Risk-weighted Tier 1 capital
ratio, percentage change
1.106674607 0.517499827 2.138502373 0.037593119 0.066171487 2.147177728
compared to the previous
quarter, %
Homeownership rate,
percentage change compared -1.201308603 3.549283396 -0.338465112 0.736488804 -8.337621037 5.935003831
to the previous quarter, %
Volume of loans insured
by Federal Housing -0.001824145 0.000762641 -2.391879289 0.020727712 -0.003357538 -0.000290753
Administration, bill. USD

Prepared by authors based on New..., 2013; Selected..., 2013; Charge-off..., 2013; Senior..., 2013.

117
 Modified effective rate of Federal Funds, Mortage charge-off and delinquency rate of 100
time lag of 5 quarters, % Residual Plot largest banks, change compared to the previous
quarter, % Residual Plot

Residuals
Residuals

Modified effective rate of Federal Funds, time lag of 5 quarters, % Mortage charge-off and delinquency rate of 100 largest banks, change
compared to the previous quarter, %

Net percentage share of banks, reporting higher

demand for mortage loans, % Residual Plot
Residuals

Net percentage share of banks, reporting higher demand for mortage loans, %

APPENDIX 11. Model error distribution

Prepared by authors based on New..., 2013; Selected..., 2013; Charge-off..., 2013; Senior..., 2013.

APPENDIX 12. White test calculation results

Prepared by authors based on New..., 2013;

Selected..., 2013; Charge-off..., 2013; Senior..., 2013.

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